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Aug 01, 2001

By Matt Valley Editor

The pendulum has swung, and now it's the tenants that have the upper hand in several office markets, commercial real estate experts agree. Slowing job growth, a tech wreck led by the dot-coms, a stagnant stock market and general economic uncertainty have combined to give tenants leverage in negotiations.

But while rental rates are dropping and bargain hunters are eager to swoop in, the sky is not falling for owners with properties in prime locations, reassured Bruce Mosler, president of U.S. operations for New York-based Cushman & Wakefield. "Like every other business line, there is clearly a slowdown in velocity," said Mosler, referring to investment sales. "I think that for prime property, the spreads between the bid and the ask [price] is not as great. There is still substantial capital out there that is looking to invest."

The secondary and tertiary markets are a different story, however, according to Mosler. "I think you will begin to see opportunities there because the rental falloff will be more substantial in the secondary and tertiary markets.," he said. Rental values had grown to unrealistic levels in those markets, Mosler added, and a return to realistic values will fuel opportunities for buyers.

In Chicago, six office projects totaling 4.5 million sq. ft. are under construction in the central business district (CBD). Three of the projects, or about 2.2 million sq. ft., are expected to come on line this year. Yet the city has experienced a 75% increase in sublease space across all submarkets since year-end 2000. The overall vacancy rate in the second quarter crept up to 10.2% from 10% in the first quarter, according to a market trend report compiled by Cushman & Wakefield.

Additionally, rental rates have softened in the Chicago CBD. The overall rental rate is down 1.5% from $27.20 in the first quarter to the $26.80 in the second quarter. The obvious question is whether there will be sufficient demand for all the space that's coming on line in the near term. Cushman & Wakefield reports that despite the increase in sublease space, which now totals 2.6 million sq. ft., the direct vacancy rate remains tight in the Chicago CBD, particularly for Class-A space.

In many ways, Chicago's office statistics mirror the national marketplace. In a newsletter titled "Office Market Trends" published earlier this summer, Northbrook, Ill.-based Grubb & Ellis reported that the vacancy rate nationally rose above 10% in the first quarter, a statistic that actually indicates a balanced office market. However, net absorption totaled negative 7.4 million sq. ft. Sublease space soared by 34%, ending the first quarter above 61 million sq. ft. Asking rents declined by 1.1% for Class-A space and 1.3% for Class-B space, and landlord concessions are beginning to appear, according to Grubb & Ellis.

The amount of competitive space under construction nationally at the end of the first quarter totaled 114 million sq. ft., down from nearly 125 million sq. ft. in the third quarter of 2000. "But the level of construction isn't coming down fast enough to make up for the plunge in new demand," according to Grubb & Ellis. "Indeed, with first quarter absorption in the red, the vacancy rate would have risen without any new supply delivered to the market."

Job growth is the fuel that drives commercial real estate. However, the loss of 223,000 jobs in April was the steepest decline since 1983, according to Grubb & Ellis, which warned that the market will struggle with a flood of sublease space if the layoffs continue. Mosler acknowledges that as companies re-evaluate their space needs and operate in a "lean and mean" mode, significant sublet space is returning to the marketplace in several 24/7 cities. "The interesting thing is that we haven't seen it impact a market or throw it out of equilibrium at this point," explained Mosler, "which might have happened in the early 1990s when we saw some of the major institutions dump space and cut employment significantly."

The freeze pattern currently gripping Corporate America is not permanent, stated Mosler, who anticipates a sharp turnaround. "At some point people are going to say, 'The opportunities out there are too great from a corporate perspective in terms of an acquisition or growth in some way, shape or form. We're going to have to move forward.'''